Japan's Improving Economy Shows That Inflation Is No Longer An Enemy

Anyone that entered the investing business in 1980 knows that it is very odd to see the central bankers of the world now focused on trying to increase inflation.

Back in the day, inflation was the enemy. An enemy Paul Volcker was locked in battle with for years as runaway inflation threatened the very core of the U.S. economy after the oil shocks in the 1970s.

Now fast-forward 30 years or so and one finds that today's enemy is just the opposite. Today everyone is worried about and focused on the potential for deflation. As a result, central bankers from the U.S., Europe and Japan have been doing their darnedest to boost the official inflation readings over the last couple years.

The key appears to be that none of the world's bankers want to see a replay of what happened in Japan from 1989 through, well, today. In short, a deflationary cycle more than 25 years ago in Japan that has kept the economy stagnant and has been a cycle that so far at least, has been nearly impossible to escape.

As a student of the Great Depression, Ben Bernanke knew that a downward spiraling deflationary cycle was the biggest threat to the U.S. economy after the credit crisis ended. As such, "Gentle Ben" did everything in his power to push up the value of such things as stocks and real estate.

Although the unemployment rate in the U.S. has come down dramatically since 2009 and the economy now appears to finally be able to stand on its own two feet, Janet Yellen's Fed is also taking no chances with deflation. While Yellen's bunch did finally put an end to their latest and greatest QE program this week, they will continue to reinvest the income from the $4+ trillion in bonds they now own and will keep rates near zero for a "considerable time."

The result of the U.S. Fed's efforts on stocks and real estate have been nothing short of impressive. While home prices have not completely recovered from their bubbly heights, they have advanced smartly from the lows. The U.S. stock market has enjoyed an advance of more than 200 percent since the dark days of 2009.

S&P 500 SPY - Daily

Japan Implementing U.S. Playbook

In light of these results, Japan's Prime Minister Shinzo Abe decided a couple years back to use the U.S. Fed's playbook with regard to ending the deflationary cycle. The plan was to implement a QE program in Japan that on a percentage of GDP basis, was even bigger than the program in the U.S.

However, the Japanese have taken the idea one step further by buying up ETFs and Real Estate Investment Trusts as well as bonds. Thus, the Japanese government was less vague about its intentions and has been directly buying stocks, bonds and REITs on the open market.

The problem is that so far at least, the plan has not been nearly as successful in Japan as in the U.S.

iShares Japan EWJ - Daily

As the chart above clearly shows, Japanese stocks have not enjoyed the joyride to the upside that has been seen in the U.S. What's more, the rate of inflation has remained stubbornly low lately. The bottom line is this appears to be unacceptable to the powers that be in Japan.

Japan Now Pulling Out All the Stops

However, this may be about to change as the BOJ shocked the financial world overnight by upping its QE program from about ¥50 billion a year to ¥80 billion -- an increase of 60 percent!

Japan's central bank said they would buy longer-term JGB's (Japanese Government Bonds) and would triple the rate of purchases of ETFs and real-estate investment trusts.

But wait, there's more. The Government Pension Investment Fund announced yesterday that it was raising its allocation to domestic equities to 25 percent from 12 percent.

It will suffice to say that Japanese officials want stocks to get moving higher.

Officially, the BOJ still believes that the Japanese economy is recovering. However, officials also voiced concerns about their efforts to win the war on deflation.

"If the current downward pressure on prices remains, albeit in the short term, there is a risk that conversion of deflationary mind-set, which has so far been progressing steadily, might be delayed," the BOJ said in a statement.

In stepping back to look at this situation, the word you are probably looking for here is, wow! The Japanese are clearly going for broke and pulling out all the stops in an effort to get stocks and real estate moving higher.

So far so good on that score as the Japanese stock market soared 4.8 percent overnight.

Why Should We Care About Japan?

The key here is that there is going to be a lot more money sloshing around the global financial system looking for a home. And if the past is any guide, a fair amount of the freshly minted money is likely to end up in the U.S. stock market.

So, while the U.S. is now stepping away from the printing press, it looks like the Japanese are planning on picking up the slack.

Oh, and speaking of more money printing, the traditionally hawkish ECB Governor Ewald Nowotny told CNBC that one "should never say never" when pressed on the topic of an official QE program in the eurozone.